Possible Compromise in EU Deficits Row

In the run-up to Monday's meeting in Brussels with the EU finance ministers, Italy has been hinting at a compromise proposal it would put forward to relax the tension that's been building over repeated breaches of EU budget rules by Berlin and Paris.

Details of the compromise haven't been released, but Italy, which currently holds the EU's rotating presidency, has said it would shift the emphasis from the "fixed parameters" of the Stability Pact, which demands that budget deficits of EU member states not exceed three percent of gross domestic product. Germany and France are set to breach that limit for the third successive year in 2004.

Brussels vs. Berlin

The row has become particularly pronounced between Brussels and Berlin. The European Commission has demanded that Germany cut next year's structural defict by more than originally planned in the country's budget proposals, meaning up to €6 billion ($7 billion) in additional savings measures.

German Finance Minister Hans Eichel has rejected these demands, arguing that the government is already implementing massive reforms and that the extra cuts would hinder Germany's fledgling economic recovery.

In a preview of the upcoming Brussels debate, Eichel faced a special question and answer session in the German parliament. The opposition conservative and neo-liberal parties, who have taken the side of the European Commission and say Germany should commit to the extra €6 billion in deficit cuts, have insisted that the Stability Pact takes priority over a planned government tax reform.

Creating a crisis

Former German Finance Minister Theo Waigel, who played a central role in creating the pact, said Germany was causing an EU crisis. "This unbelievable fiscal and monetary policy course makes me absolutely livid," he told the German Nürnberger Nachrichten newspaper.

European Central Bank chief Jean-Claude Trichet urged all EU governments to abide by budget rules. "This, something like the Stability and Growth Pact has very, very strong economic underpinnings in a single (currency) zone, which is not a federal entity," Trichet told CNBC television. "I very profoundly wish and hope that all partners concerned will be up to their responsibilities."

Dutch Finance Minister Gerrit Zalm has taken an even harder line on Germany's deficit than the European Commission. "The demands of the Commission don't go far enough," Zalm said. As for a possible Italian-brokered compromise, Zalm said that such action would damage the Stability and Growth Pact. "If it's found, the pact won't be dead, only hurt," he told Die Welt newspaper.

Banks urge flexibility

German banking experts, on the other hand, are demanding flexibility. The chief economist of the HypoVereinsbank, Martin Hüfner, showed understanding for Eichel's predicament. "As long as the economic recovery remains so weak, there's absolutely no sense in cutting back the deficit," he told the Berliner Zeitung. "In such a situation, you just have to tolerate the deficit."

Germany has been fighting hard to avoid budget disciplinary procedure, which can ultimately lead to massive fines. If the European Commission were to recommend sanctions against Germany, a two-thirds majority of EU finance ministers would have to give their approval. The Commission has told ministers to stand up to France and Germany and avoid a political compromise.

But according to Sweden's minister for international economic affairs, Gunnar Lund, Germany has enough votes to get its way. "Germany and France have succeeded in creating a blocking minority to prevent a decision from being adopted," Lund said, adding that Italy and Britain would back Berlin.

Given that scenario, senior EU diplomats say compromise is the least damaging option now.